Sunday, September 28, 2008

It seems that Congress is likely to approve a plan that could resolve the current financial mess. It won't be a "bailout" in the sense that the government will repair the losses suffered by people who made bad decisions or were the unwitting victims of predatory lending. The government will in effect step in to shoulder some of the risk and uncertainty that seem to have paralyzed the financial markets. And for doing that government will extract a heavy price.

Treasury will get the authority to spend several hundred billion to buy troubled assets, and this should relieve some of the pressure on the banking industry. It's not a terrible arrangement at all: Treasury will be buying interest-bearing assets at distressed prices, and under normal circumstances that is a value investor's dream come true. Congress will have an option to recoup some of the losses if it doesn't work, and that will please those critics of bailouts who don't understand that if the plan doesn't work and all heck breaks loose, the banks won't have the ability to pay a tax in the future. But if all goes well, as is likely, then everyone is going to be happy. So I would look for this to produce positive results in the near term.

The things to worry about are the long term consequences. Moral hazard is going to be very much alive and well. Markets will learn once again to expect the government to come to the rescue whenever misguided government policies lead to predictable, disastrous results. Politicians (and, I would note, the Federal Reserve) will once again escape the blame for having created this mess in the first place. Voters will once again fail to understand that the problem is too much government, not insufficient government. Government will have more influence over the economy, the private sector less. Though very unfortunate, it's not going to be the end of the world, just another setback on the (sure to be slower) road to progress.

Meanwhile, for a look at what might have been a better solution, check out Brian Wesbury's alternative proposal, which calls for a fairly simple change in the accounting rules. He notes something that others have missed, by the way, which bears repeating here: if Treasury ends up making a profit on this "bailout" plan, then that profit will accrue at the expense of the private sector, and that equates to a tax. So if the plan works, the government could end up collecting a big, indirect tax on the financial sector. If the plan doesn't work, the government gets the option of imposing a big direct tax on the financial sector; and as we all should know, businesses never pay taxes—it's always the consumer that pays the taxes. So it's a win-win for the government, and a win-lose for the consumer: we escape a financial crisis caused by the government only to be burdened in the future by a more oppressive government presence in our lives.